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Financial Reporting Implications of Disasters

North America has been affected by a series of natural disasters in recent weeks, including Hurricanes Harvey, Irma and Maria, and two significant earthquakes that struck Mexico within a span of 12 days. Disasters can also take other forms, such as the September 2001 terrorist attacks on the World Trade Center in New York and the Pentagon outside Washington, D.C.

In addition to tragic loss of life, disasters can cause widespread damage and destruction of property and varying degrees of business activity disruption in affected regions and, in some cases, other areas of the world. Some entities may have principal operations in the affected area, while others may have ancillary operations or interests in the affected region. Other entities may be affected as a result of relationships with major suppliers physically located in the affected region. In addition, insurance entities may experience significant losses as a result of a disaster.

A number of financial reporting implications can arise as a result of a disaster. Such implications can include the accounting for asset impairments, income statement classification of losses, insurance recoveries, and additional exposure to environmental remediation liabilities.

Following is an excerpt of a Financial Reporting Alert from Deloitte & Touche LLP that identifies potential implications and applicable authoritative guidance. The financial reporting implications discussed below and in the Alert are not intended to be all-inclusive but as a starting point for thinking about the issues that might arise.

Asset Impairments

A disaster can result in the impairment of assets. The analysis of whether a disaster results in an impairment, and the resulting measurement of impairment, is often difficult after a disaster because there may be many uncertainties about the prospects of the asset or group of assets. Entities should consider the guidance below in performing their impairment assessments.

Long-lived Assets

U.S. GAAP on property, plant and equipment and the impairment or disposal of long-lived assets in ASC 360¹ requires entities to test a long-lived asset or group of assets for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable (see ASC 360-10-35-21). For example, the impact of a disaster may cause entities to assess the recoverability of long-lived assets in accordance with ASC 360-10-35-21 because there may be any of the following:

—“A significant decrease in the market price of a long-lived asset (asset group).”

—“A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition.”

—“A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.”

—A significant decline in the asset’s (or asset group’s) capacity to generate income or cash flows such that forecasts demonstrate continuing losses.

ASC 360 requires that entities group long-lived assets to be held and used for impairment testing at the lowest level for which identifiable cash flows are largely independent of cash flows of other assets and liabilities (see definition of asset group in ASC 360). If the long-lived asset group is not deemed recoverable, an impairment loss is measured as the amount by which the carrying amount of the asset group exceeds its fair value (see ASC 360-10-35-17).

In some cases, entities may conclude that long-lived assets affected by a disaster will be disposed of by sale or abandonment. When the “held for sale” criteria in ASC 360-10-45-9 through 45-11 are met, entities are required to recognize a loss for any initial or subsequent write-down of the disposal group to fair value less costs to sell. Long-lived assets to be disposed of by abandonment should continue to be classified as held and used until disposed of with recoverability testing as described above.

If the disaster occurs near the end of the next financial reporting period, it may create challenges for entities when they are assessing their plans for the affected assets (e.g., repair and return to service, hold for sale, abandon) as well as the related cash flow effects of each plan.

Overview of Insurance Analysis

Assessing the extent to which insurance coverage exists may be challenging and require the assistance of an entity’s legal counsel. In determining the accounting for insurance recoveries, an entity should first perform an assessment similar to the following:

—Does the entity have insurance, and is the specific loss insured? The entity should consider whether “insurance” actually exists and whether the specific events are covered. For example, as discussed below, an entity may have finite insurance that does not necessarily transfer significant insurance risk.

— Will there be disputes over the cause and extent of the damage? In determining the amount of expected insurance recoveries to recognize, an entity should consider the potential for disputes with the insurance company and its likelihood of prevailing.

—What is the financial viability of the insurance company? Before recording an insurance receivable, entities should consider the insurer’s ability to pay. Entities can look to the following in making that assessment:

—Quarterly and annual statutory filings. A first step is to consider whether the insurer’s surplus/capital is large enough to cover estimated losses. Another factor to consider is how much of the insurer’s business is located in an affected region.

—An entity’s insurance broker (if applicable) or a rating agency may have already performed these assessments and may be able to provide additional information.

Not all clean-up costs will represent an environmental remediation liability or have to be accrued. ASC 410-30-25-1 refers to ASC 450, which clarifies that a liability would be recognized when evidence indicates that a liability has been incurred as of the date of the financial statements and the amount of this liability can be reasonably estimated.

Given the nature of environmental remediation obligations, the “probable” criteria triggering recognition are presumed to have been met when litigation has commenced or a claim or an assessment has been asserted on or before the balance sheet date; or commencement of litigation or assertion of a claim or an assessment is probable on the basis of available information (see ASC 410-30-25-4(a)) and it is probable that this litigation, claim, or assessment will be unfavorable (see ASC 410-30-25-4(b)).

Making such a determination in light of the uncertainty that is often associated with a disaster may be extremely difficult. In addition, rubble of damaged buildings and equipment or leaked toxins may never result in litigation or another remediation liability under a law or statute. Clean-up costs, other than those that create an obligation in accordance with ASC 410-30 or that result in other litigation requiring an accrual in accordance with ASC 450, should not be recorded until incurred (i.e., when the clean-up takes place), even though such expenses could be triggered by the disaster event.

Future Operating Losses

An entity may forecast operating losses for a certain period after a disaster. Such losses may result from clean-up and repair costs directly attributable to the event. Other losses may be indirectly related to the event, such as those resulting from declines in customer demand or disruptions in the supply chain. Future operating losses do not meet the definition of a liability, nor do they qualify for accrual under ASC 410-30 or ASC 450. Such losses should be reflected in the period in which the related costs are incurred.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.
Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.
As used in this document, “Deloitte” means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting.

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